Exchange Rates and Monetary Policy Amid Geopolitical Conflicts

The Israel-Hamas conflict has lasted over a week, and the market’s concern about entering a “long-term attrition war” has increased compared to before. Global stagflation and energy diversification have become the main trading themes. Meanwhile, the foreign exchange market is also changing. The US dollar index has risen from around 97.7 before the conflict to approximately 99.6 now, and the RMB exchange rate has climbed from about 6.8 to above 6.9, though the upward momentum faces short-term resistance.

Looking back at the four previous oil price shocks (two oil crises, the Gulf War, and the Russia-Ukraine conflict), the US dollar’s movement has been mixed overall. In the earlier instances, it mostly declined, while during the Russia-Ukraine conflict, it surged significantly. In summary:

1. Rising oil prices do not directly determine the direction of the dollar. The key variable is the Federal Reserve’s monetary policy stance, especially the direction of real interest rates. When the Fed adopts a dovish approach to inflation (such as in 1973 under Burns), rising oil prices often coincide with a weakening dollar. Conversely, when the Fed takes a hawkish stance to curb inflation (such as in 1980 under Volcker or in 2022 under Powell), rising oil prices tend to be accompanied by a strengthening dollar.

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